Although Australia fared better than most after the 2008 global financial crisis, there were nonetheless casualties. Some of these were clients of Storm Financial Ltd. Recently, the Federal Court of Australia held that both its directors had breached their statutory duty of care and diligence. The case provides a timely reminder of directors’ duties and the willingness of regulators to act when directors fail to honour their obligations. Below, we discuss the case and provide an overview of directors’ duties under the Corporations Act 2001 (Cth) (the Act).
What are a Director’s Duties Under the Act?
Company directors have five statutory duties, namely:
- Duty of care and diligence;
- Duty to avoid a conflict of interest;
- Duty to act in good faith;
- Duty to act for a proper purpose; and
- Duty to prevent insolvent trading.
A breach of directors’ duties can result in both criminal and civil action. Penalties include paying substantial fines and possibly imprisonment.
In 2010, the Australian Securities and Investment Commission (ASIC) instituted proceedings against Mr and Mrs Cassimatis, the only directors of Storm Financial Ltd (Storm). ASIC alleged that both had breached their duty of care and diligence owed to the company under Section 180 (1) of the Corporations Act 2001 (Cth).
Storm provided financial services according to a model developed by Mr Cassimatis. This double gearing model allowed clients to borrow against the equity in their homes and to use those funds to invest in index funds and establish a cash reserve. During the global financial crisis, these investors suffered huge losses on account of the double gearing characteristics of this model.
ASIC asserted that Mr and Mrs Cassimatis (the only shareholders of the company) had breached the duty of care and diligence while the company was solvent. The reason for this is that Storm gave financial services as per the model to vulnerable and older investors. These investors had limited assets and income, and little chance of financial recovery if they were to suffer loss. In so doing, the company breached the requirement, then in the Act, that there be a reasonable basis for financial advice to retail clients.
Mr and Mrs Cassimatis, who the Court determined had ‘an extraordinary degree of control over Storm’, had breached their directors’ duty because they caused or allowed the company to give advice to investors which caused the company to breach the Act. These actions exposed the company to the risk of harm including the loss of its Australian Financial Services Licence, a banning order and civil litigation brought against the company by investors.
What Did the Court Decide?
The Court held that:
- Storm had breached the Act; and
- Mr and Mrs Cassimatis had breached their duty of care and diligence because a reasonable director of a company in Storm’s particular situation and with the responsibilities of Mr and Mrs Cassimatis would have been aware that the company would likely breach the Act. That is, in exercising their powers the directors caused or allowed Storm to use its model with clients near retirement with limited assets and income.
Critically, the fact that neither believed that capital loss could happen using their model and acted honestly did not excuse them under Section 1317S (Relief from liability for contravention of civil penalty provision) of the Act. Their significant roles and responsibilities together with the fact that the company’s contravention of the Act was so severe, lead to the Court not providing them with relief.
What are the Implications for Directors?
While directors owe their duties to the company, the company’s interests are not limited only to the interests of its shareholders and include financial loss and reputation. Breaches of directors’ duties is a serious matter, and ASIC will act if the circumstances of a breach warrant it. If a director is unsure of their responsibilities to their company, the onus is on them to find out about the legal obligations associated with their position.
If you have any questions about your obligations as a director, get in touch with our commercial lawyers on 1300 544 755.